Competitiveness Index

The World Economic Forum has released its 2007-2008 Global Competitiveness Report. Not surprisingly, the US come out on top, with Switzerland, Denmark, Sweden, Germany, Finland, Singapore, Japan, the UK and the Netherlands close behind. What I find interesting, however, is how closely these countries are usually ranked. There is not a huge difference – which is surprising when one considered the difference in public policies in the various countries. The top ten has a mix of more economic laissez faire, interventionist, “old Europe” and the Nordic model.
New this year is a survey of corporate leaders regarding each country’s business climate. According to the Financial Times, this “impressionistic” may cause problems:

This year’s annual ranking exercise will confuse avid WEF watchers as a change in the methodology has promoted some countries such as the US and Germany far above last year’s published league table positions, while demoting Finland, once almost always top of the tree to sixth place.

I’ve always found the Global Competitiveness Report to be a useful study. But, like any other analysis and ranking, it needs to be taken with a grain of salt. These surveys of business climate have always struck me as one of those things that need to be taken carefully. Worthwhile, but certainly not the definitive answer on how well we are doing.

UPDATE: Here is the Wall Street Journal’s take on the other changes in the methodology:

The U.S. jumped to first from sixth place last year, according to the ranking by the World Economic Forum, a Swiss institute best known for hosting a big annual meeting of business and political leaders in Davos, a ski resort, each January.
However, that sharp climb was due to a change in methodology that gives more weight to market-related factors in the survey, relative to the fiscal and public-policy criteria on which the U.S. is weak. Under the new methodology, the U.S. would have topped the rankings last year too.
“The U.S. does amazingly well on innovation and markets, but on the macroeconomic stability pillar it ranks 75th,” out of 131 countries included in the survey, said Jennifer Blanke, the Forum’s chief economist and a co-author of the report. “This still reflects a very serious problem that could hurt the U.S. in the future.” Fallout from the recent credit crisis is an example of that risk, according to the survey’s authors.

Overrun by information

I’m a bibliophile. As a child I was a voracious reader. The World Book Encyclopedia was one of my favorite toys. Not only were the words and pictures fascinating, the heavy books made a great building material for forts and other construction projects. Having been a voracious reader of the small library at home, my first reaction to a public library (in my case, the school library in my Catholic elementary school) was a shock. How in the world was I ever going to read all those books?
That is the same reaction I had when I read Anthony Grafton’s essay in the latest issue of the New Yorker — Future Reading: Digitization and its discontents:

In fact, the Internet will not bring us a universal library, much less an encyclopedic record of human experience. None of the firms now engaged in digitization projects claim that it will create anything of the kind. The hype and rhetoric make it hard to grasp what Google and Microsoft and their partner libraries are actually doing. We have clearly reached a new point in the history of text production. On many fronts, traditional periodicals and books are making way for blogs and other electronic formats. But magazines and books still sell a lot of copies. The rush to digitize the written record is one of a number of critical moments in the long saga of our drive to accumulate, store, and retrieve information efficiently. It will result not in the infotopia that the prophets conjure up but in one in a long series of new information ecologies, all of them challenging, in which readers, writers, and producers of text have learned to survive.

Learning to survive seems to be an appropriate operative condition. More and more I feel overrun by information. I find it harder and hard to find the piece of information I am looking for on the web, when the search engines return thousands of items to my queries. Grafton’s essay is a wonderful history of our fight to stay ahead of the tide. He also describes the role of books as physical artifacts — full of annotations and such which provide insights into the social life of the information.
As the essay points out, we will continue to be overwhelmed with information. That seems to be a defining characteristic of the I-Cubed Economy. Coping mechanisms include new information technologies. But there will still be the old fashioned bibliographic version of shoe leather approach — wading through tons of not-so relevant information. The flip side of that is the strong positive: the joy of discovery!
BTW – Grafton has also provided an online companion to the essay — Web Sightings: Adventures in Wonderland — which contains a wealth of links and reference points.

Services trade with China

I’ve always been impressed that when the editorial board of the Wall Street Journal gets it wrong, they get it wrong big time. The latest is their attempt to down play the trade deficit, especially with China — A Services Surplus. In that editorial they celebrate our surplus in services trade and “gains America reaps from doing business with China” from “doing a booming business — in services as well as goods.” In other words, everything is just fine.
As the regular read of this blog knows, I publish the monthly breakdown of our trade in services and intangibles (see last month’s numbers). One of the keys to that analysis is to separate out the types of “services” that are reported in the data. The other is to put that data into context.
First, the issue of what are “services”. Trade data on services includes five major categories: travel, passenger fares, other transportation, royalties and license fees and “other private services.” So, in other words, when a foreign good is shipped into the US, part of the cost of that imported good shows up as a “service” export.
To get a clearer picture, I use only the last two: royalties/fess and other private services. The latter is a catch all for a large number of services: education, financial services, insurance services, telecommunications, and business services. International trade in services has been rising steadily. Our surplus in these financial and business services was $72 billion in 2006. But what the Journal’s editorial failed to mention that, in 2006, US imports of “other private services” grew faster (17%) than exports (14%). Our $3.575 billion surplus in these services with China in 2006 was only barely higher than our $3.50 billion surplus in 2005. More worrisome, our imports of services from China grew much faster than our exports (but still at a low level).
Second, the context. That $72 billion financial and business services surplus in 2006 is less than 10% of the $838 billion deficit in goods. And that $3.575 billion surplus with China is 1.5% of our $232.6 billion deficit with that country in 2006.
Trade in intangibles, including business and financial services, is important and growing. But to think that our trade in services is going to offset our deficit in goods — and proves that everything is just fine — is more than wishful thinking. It isn’t even whistling past the graveyard (to use the Halloween rhetoric). It is simply irrelevant.

Intangibles and Iraq

From today’s “Department of Human Behavior” column in the Washington Post — One Thing We Can’t Build Alone in Iraq:

Ideas related to social capital have many applications to U.S. domestic challenges but are especially instructive to the situation in Iraq, because they suggest that the model of reconstruction the United States has pursued there is fundamentally flawed.
The problem with an external agent handing down largesse — building bridges, roads and schools, for instance — is that it runs counter to everything known about how social capital grows, [Robert] Putnam said. And without social capital, societies fall apart, even if the roads are smooth and the trains run on time.

(Note: Putnam is the author of the influential book on social capital – Bowling Alone)
But the problem of building social capital is not unique to Iraq (although the process is under more stress there than elsewhere). Intangibles like social capital are often overlooked, I feel, in most development projects. Even macroeconomic policies don’t take these human intangibles into account (after all, even the idea that institutions matter is a relatively new idea in modern, mainstream economic thought). For example, the shock therapy that worked in Poland’s return to capitalism failed in the Russian case where social capital is seen to be much lower.
The situation with respect to social capital and development is slowly changing, as the story points out:

Michael Woolcock, a sociologist at the University of Manchester in England who worked for years at the World Bank, said one development project in Indonesia suggested that external agents might be able to help build social capital.
The trick, he said, was to make no centralized decisions at all, whether in Jakarta or, even worse, Washington. The Kecamatan Development Project has aimed more than $1.3 billion at more than 40,000 villages, but every decision about how to use the money has come from democratic decisions at the village level, where funds are released only if diverse groups can show they are willing to work together. It has sometimes been described as a democracy project disguised as a development project.

The World Bank has been thinking about how to build social capital. In fact, they have done a lot of research on the subject and have a website devoted to the topic. The problem, as with many things, is implementation. Bricks and mortar (roads, bridges, and buildings) are easy to measure and show off. Making progress in building social capital, like other intangibles, is more difficult. But ultimately, it is the intangibles that make the bricks and mortar work.

Green to China – or green by China?

One of the standard responses to the trade deficit with China is to point to the opportunity to sell China green technology. The US, it is said, can export advanced technology to China to solve their environmental problems. While I have always thought that green technology is a good opportunity for US companies, I have been a little wary of the claim about solving our trade deficit that way. In part, there has been this nagging in the back of my mind that this assertion assumes the old paradigm of trade: advanced countries develop the technology at home and then export the second generation to the “developing” nations. This assumption is failing to meet the new reality test of the global technology development.
The latest on this comes from a story in today’s International Herald Tribune —
GM plans a research center in Shanghai for hybrid technology:

General Motors announced here Monday that it would build an advanced research center in Shanghai to develop hybrid technology and other designs, in the latest research investment in China by a foreign automaker despite chronic problems with purloined car designs.
. . .
Planned for weeks, the Monday announcement coincidentally came right after the Chinese government’s powerful National Development and Reform Commission disclosed Friday that it was drafting stringent local content rules for alternative fuel vehicles to qualify for likely government subsidies. The rules will require that key components be manufactured in China.
“They don’t want to give big incentives just for people to import stuff,” said Nick Reilly, a GM group vice president who runs the company’s Asia-Pacific operations.
The Chinese government’s move is aimed partly at Toyota, which assembles Prius gasoline-electric hybrid cars in China but ships the critical components in sealed boxes from factories in Japan.

Clearly, the Chinese want to go green by producing and developing the technology at home – rather than simply importing it from others. And apparently, Toyota and the Japanese are working on a strategy for making sure that they create home-country exports out of these sales abroad – beyond just the royalty stream. It is not clear the American’s have figured out how to do either of these — or if whether they should or not.

Understanding contagion

I think I’m beginning to slightly understand the credit market melt down. The issue isn’t the collapse of the subprime mortgage market – although that is a part. The real issue seems to be the leverage built on top of that subprime mortgage market, especially the banks’ Special Investment Vehicles (SIV). SIV are off-book entities banks have set up to hold some of these assets. As a recent Wall Street Journal story explains:

There’s nothing special about how SIVs invest their money. They own the usual assortment of bank debt, mortgages and other asset-backed instruments. What’s striking is how they are set up, with huge amounts of leverage on a slim capital base; with bank sponsors that don’t own them but instead collect management fees for running them; and with their funding derived mostly from short-term commercial paper.
Put those three factors together, and it’s clear that SIVs can make tidy profits for banks when things go well. But they are vulnerable to a liquidity squeeze if the commercial-paper market dries up. That’s what happened this summer.

Or as another story says:

SIVs sell short-term debt and then use the proceeds to buy longer-term, higher-yielding securities. But SIVs have had trouble in recent months selling debt, and some of their roughly $350 billion in assets are backed by U.S. mortgages — a market that has seized up amid the housing slump and subprime-lending shakeout. Typically, money-market funds, municipalities and other risk-averse investors buy SIV debt.

But when these investors stop buying and the short term debt comes due, the liquidity problem sets in. To compound it, prices of the long-term investments drop in the thin market. Caught between an inability to raise new short term cash and an inability to sell their long term assets, bankruptcy (either official or unofficial) is the result.
I point this out because of the relevance of the subprime market fiasco to the monetization of intangible assets. Like the mortgage market, intangibles such as brand names have been packaged into special purpose entities and bonds backed by those assets sold as securities. In both cases, the cash flow from the original assets — the mortgage payments or the brand royalties — is what backs the original bond. With the rising defaults in the subprime market, that cash flow to support the subprime mortgage backed bonds became unstable. But that is not what caused the panic. Properly treated, that was containable. Owners of those bonds would have simply taken as right off of some portion and move on. But this only works if the owners don’t need to sell these assets to cover other debt. So what caused the panic was the banks high-low game of essentially interest rate arbitrage using the subprime backed bonds as the vehicle on the high end (and the commercial paper market on the low end).
So far, I don’t know if any intangible asset backed bonds have gotten into any cash-flow problems recently. There have been some in the past. But unlike the covenant-lite deals with subprimes, these intangible asset backed deal have all sorts of trip-wires and covenants to deal with cases of inadequate cash flow.
Having said that, the subprime and SIV meltdown will certainly have a negative impact on any future intangible-asset backed securitization deal. Guilt by association is likely to be the rule. The trick of those trying to push the concept of intangible securitization will be to convince investors that these assets are different. That may be a very hard row to hoe.

Design moves ahead

The CONNECTING’07 World Design Congress – Connecting to People and to Ideas was held last week and according to the write up of the conference by Business Week – Making Connections By Design – the design community is in a buzz:

Designers, not regularly hailed for their shyness or lack of confidence, were in their element. The atmosphere was ebullient and the consensus clear: Design’s moment is now.

I would like to think that is true. But in order for that to happen, “design” needs figure out what it wants to be now that it has grown up:

How exactly designers might take advantage of business’ new-found interest in using design to improve bottom lines was, however, less clear. “The design community is faced by unprecedented opportunity to chart a new course—and most of us aren’t sure what to do with that opportunity,” admitted Peter Mortensen of Jump Associates, the San Mateo (Calif.) innovation consultancy, which sent eight people to the conference. “We’ve spent so many decades arguing with businesspeople that we need a seat at the table. It was a war to make that case. And now we’ve won the war, people are struggling with how to win the peace.”

For me, design has to move well beyond “cool” and certainly beyond simply coming up with new gizmos and gadgets — however cool or useful. (BTW – if you are into that aspect of innovation and design, see GizMag.
Fortunately, there are signs that the design community is way ahead of me:

Academic figures Patrick Whitney, director of the Institute of Design at IIT and Roger Martin, dean of the Rotman School of Management in Toronto, were on hand to elucidate how designers can learn to speak the language of business. In quite possibly the highlight of the conference—certainly the only keynote to provoke a spontaneous standing ovation—British academic adviser and creative ambassador Sir Ken Robinson outlined the need for all members of an organization to be encouraged to think creatively, to bridge the divide between the “creatives” and the “suits.”

Sounds like the right direction to me.

Counting on intangibles — not in DC

Yesterday, the DC City Council voted on a plan to support a local hospital in danger of closing — see Hospital Deal Gets Financing From D.C. – This vote came in spite of a last minute warning by the city’s Chief Financial Officer. Part of the warning in the CFO’s Fiscial Impact Statement is because the hospital’s “liabilities exceed tangible assets by approximately $34 million.” The company’s financial statements carry $34 million of goodwill.
I’m not an accountant and I haven’t seen the company’s financial statements. Thus, I am in no position to argue one way or another on the CFO’s bottom line concern that “should the business plan fail, it is likely that additional funds of substantial amounts will be needed to keep the Hospital running.” I think that is probably a truism — if any business plan fails, additional investments are probably needed to keep the operation going. The risk that city is taking is that it is potentially signing on to a long term hospital subsidy (but that is exactly the risk they may need to take to provide health care — a question well beyond my job description).
I do find the CFO’s reliance on only tangible assets of specific interest. Again, without having looked at the company’s financials, I can’t make a call here. Many financial sins can be hidden under the category of “goodwill” (which is exactly why FASB eliminated pooling and requires companies to break out intangibles from goodwill in acquisitions). But I have to believe that that well-run hospitals have a huge amount of intangible assets.
The Post story gets to this point:

One of [CFO Natwar] Gandhi’s main points of contention involved Specialty’s claim of $34 million in “goodwill” assets, which the company expected the city to accept as proof that it could cover its liabilities.
“Goodwill” is an accounting term used to characterize assets that are not tangible — the value of a company’s name or its customer base, for example. In Specialty’s case, the goodwill referred to the value of its two other D.C. hospitals, which provide skilled nursing and long-term acute care. The company maintains that the facilities are worth more than the simple value of their medical equipment.
But Gandhi decided that goodwill represents “intangible assets” that should not count toward Specialty’s ability to meet its liabilities, government sources said.
[Company representative George] Lowe disputed Gandhi’s analysis. He said Specialty had $84 million in gross receipts and turned a profit of $14 million this past year. He noted that its hospital in Southeast sits on 66 acres appraised at $35 million, and its Capitol Hill facility is worth $15 million for its business operations alone.
“The company is not insolvent,” Lowe said. “The company is performing very well.”
Audited financial statements back up its claims, he said.

(Apparently those audited financial statements were never made available to the city’s CFO).
Earlier this year, I posted an item on the new rules for account of state and local intangible assets.. Again, without having seen the company’s financial statements, and not being an accountant, I can’t say whether applying these rules would result in a different outcome by the CFO.
The other part of this transaction that concerns me is whether the intangible assets were included in the deal. Not having seen the details of the deal, I can’t speak to whether any of the company’s intangible assets might be used as collateral to backstop the city’s investment. But if the company is going to claim intangible assets as a major part of their asset base, the city should have a claim on those assets if the deal goes south. It appears from the CFO’s analysis that the only backstop for the city (outside of being a standard unsecured creditor) is part of the real estate.
Given that hospitals are a prime example of a knowledge-based, intangible-heavy institution, there was a missed opportunity here. Completely excluding intangible assets results in an incomplete picture of the company (and the investment proposals) and in a failure to capitalize on those intangibles as part of the deal. The fiscal impact statement should have included an analysis of the intangible assets and the deal should have been structured to incorporate those intangibles into the financial arrangements.

Snippets on the role of patents

From Business Week – A Life in Invention: Xerox’s chief scientist Robert Loce talks with Jessie Scanlon:
On collaboration:

These days it’s hard to come up with a really useful widget. You have to integrate what you’re doing into a system. And when you’re working with a system you have to work with experts in multiple fields. So, for instance, I’m an imaging scientist, but I might need to work with experts in sensors and programming and actuators. To have an invention that’s really critical, you need people with different skills working together.

On the innovation process:

Occasionally I’m part of the product team that actually helps develop a finished product. Other times I’ve invented something, and thrown it over the wall to good engineers who improve my idea and get it to work. Finally, if a Xerox product team isn’t interested, I work with the Xerox licensing department to find an outside organization interested in the technology.

On defensive patenting:

A patent is really a contract you have with the government to prevent others from doing your idea.
. . .
in the late 1980s, Xerox was issued a patent on one of my inventions that sat dormant for quite a while. At some point I told a person in our legal department to not bother paying the maintenance fees on that patent because it did not seem to bring Xerox any value. But it turned out that a competitor had approached us on this patent. For some reason we did not work out a licensing agreement. As a result, this competitor didn’t fully implement the feature that they desired. Also it took quite a while for them to bring their scaled-down version of the feature to market. So, our patent seems to have blocked their use of a technology and might have resulted in longer development to work around our patent.

From a public policy point of view, I agree with everything except the last point. I take defensive patenting as the dark side of the process — in order to spur innovation (by providing monopoly incentives) we have to give someone the right to throttle innovation (by granting that monopoly).
An interesting system.

Does reputation matter?

Apparently, the intangible of reputation is not as important as we might have thought on Wall Street. From Dennis K. Berman’s column in today’s Wall Street Journal – Stakes Change Rules on Value Of Reputation:

But it turns out that there are natural limits on how reputation — the esteem with which one is held by others — can affect behavior. We’re seeing those limits now, as the world’s credit crisis plays out before our eyes.
“Reputation matters until you get to some serious pain,” says Edward Rock, co-director at the Institute of Law & Economics at the University of Pennsylvania. “It matters if the stakes are low. Somewhere between $25 million and $1 billion, it shifts.”
How else to explain how banks, private-equity firms, bond salesmen, boards of directors, and hedge funds are wheedling, reneging on and resetting all sorts of business contracts and promises.
“I would love to say yes, that reputation matters,” said one top deal maker on Friday. “In principle it does. Still, the line is not as bright as that implies.” Indeed, the breadth of this current crisis has created what might best be described as a reputational free-fire zone.
. . .
“People can plead that ‘I’m not a bad actor. I haven’t broken my word if everyone else is doing it,’ ” says Lisa Bernstein, a legal scholar at the University of Chicago who has studied the role of reputation among tight communities such as cotton and diamond traders. “It’s going to give quite a bit of cover.”
Ms. Bernstein has found that reputation-enforced business networks work best among tight-knit groups. Once these networks expand, business people are forced to rely on formal legal contracts. The irony is that these contracts — hundreds of pages thick — are often no more effective than simple informal agreements based, essentially, on reputation.
That’s reflected in the larger structural changes on Wall Street. In 1907, it was J.P. Morgan himself who helped calm a dangerous credit crisis, putting his good name behind a rescue plan. Today, J.P. Morgan Chase & Co. is an immense and largely faceless institution of 180,000 people, full of committees and project teams. Its reputation is harder to pin down because it’s difficult to assign responsibility in the first place.
It’s also easier to engage in reputation-damaging behavior if there are few competitors looking to take away business. By all indications, it would be very hard for both corporations and private-equity firms to lock out J.P. Morgan and Bank of America because they balked at funding the $25 billion acquisition of student lender Sallie Mae. The two banks simply have too much sway in the market.

In other words, when money talks, reputation walks. At least on Wall Street.